Vanna-Volga Methods Applied To Fx Derivatives: From Theory To Market Practice
AbstractWe study Vanna-Volga methods which are used to price first generation exotic options in the Foreign Exchange market. They are based on a rescaling of the correction to the Black–Scholes price through the so-called "probability of survival" and the "expected first exit time". Since the methods rely heavily on the appropriate treatment of market data we also provide a summary of the relevant conventions. We offer a justification of the core technique for the case of vanilla options and show how to adapt it to the pricing of exotic options. Our results are compared to a large collection of indicative market prices and to more sophisticated models. Finally we propose a simple calibration method based on one-touch prices that allows the Vanna-Volga results to be in line with our pool of market data.
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Bibliographic InfoArticle provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.
Volume (Year): 13 (2010)
Issue (Month): 08 ()
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Web page: http://www.worldscinet.com/ijtaf/ijtaf.shtml
Other versions of this item:
- Fr\'ed\'eric Bossens & Gr\'egory Ray\'ee & Nikos S. Skantzos & Griselda Deelstra, 2009. "Vanna-Volga methods applied to FX derivatives : from theory to market practice," Papers 0904.1074, arXiv.org, revised May 2010.
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- Griselda Deelstra & Grégory Rayée, 2013.
"Local Volatility Pricing Models for Long-Dated FX Derivatives,"
Applied Mathematical Finance,
Taylor and Francis Journals, vol. 20(4), pages 380-402, September.
- Griselda Deelstra & Gr\'egory Ray\'ee, 2012. "Local Volatility Pricing Models for Long-dated FX Derivatives," Papers 1204.0633, arXiv.org.
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